Economic Highlights

New Delhi, 12 June 2009

Beginning Of Difficult Era

FM ENCOUNTERS HURDLES

By Shivaji Sarkar

The budgetary process ushers in the first phase of a difficult era. The country is besotted with scarce resources, poor finances, fall in revenues and high deficit. Yet it has to answer these with budgetary solutions to accelerate growth, create jobs, reduce, if not eliminate, poverty and ensure a low-interest, low-cost and high productive regime.

The Finance Minister Pranab Mukherjee has struck the first two hurdles. The bankers are unwilling to cut interest rates and the State Finance Ministers do not want to stick to the low deficit model that the Fiscal Responsibility and Budget Management Act imposes on them.

The State Finance Ministers want to throw to winds the fiscal norms that the International Monetary Fund has been able to push through during the last two decades. It stipulated managing the finances within the limits of revenue earnings by doing away with the system of deficit financing. Higher deficit financing also leads to an inflationary situation.

The Central Government is in a quandary. The critical situation has left it with little choice. The Finance Minister is cajoling the banking sector to come to its rescue by ensuring a low-cost banking regime. This is needed to ensure capital flow as also help all those who want to contribute to the growth of the economy.

The banks are in a catch 22 situation. They are custodians of the people’s money. Difficult times also mean high-risk banking because the capacity to repay suffers. The public sector banks already have an increase of Rs 5,000 crores in bad loans. In March 2008, they had bad loans worth Rs 40,269 crores. It has risen to Rs 45,157 crores. This means that larger sums are going out of the public domain. It also means that the good customers and investors are being penalized with higher costs and low interest rates.

Another source of the earning by banks is lending money. It is evident this has become high risk. Besides, actual lending by banks has reduced despite the so-called touted signs of recovery and impressive claims by the Planning Commission Deputy Chairman Montek Ahluwalia. Overall, bank credit fell by an estimated Rs 51,071 crores during 1 April 1 and 22 May this year. The trend had started last year itself. During the same period last year the fall in credit was Rs 10,650 crores.

This is also marked by the fall in the credit-deposit ratio (amount of credit disbursed out of a unit of deposit received by banks) to 68.95% on 22 May from 71.04% for the fortnight ending 10 April 2009. It is usual for credit to slow down during the new fiscal. The slide, however, has been higher than expected. Bankers ascribe this to the recessionary condition and do not expect a recovery till December.

The off-take by the industry has come down because of slackening demand. The small and medium industries (SME) have been worst hit. The SMEs have been facing payment problems from buyers and demand deceleration from big companies. The banks are wary of extending credit to them. This is a telling sign of the direction of the economy.

The gross advances by the banks are coming down since 2007. In 2006-07 the gross advance growth was 28.5%, in 07-08 it came down to 23.14% and in 08-09 touched 19.72%. Similarly the educational loan growth came down to 39.51% in 08-09 from 42.65% in 06-07.

The worst hit has been the housing finances sector which decelerated from a growth of 23.22% in 06-07 to 12.7% in 07-08 and 5.9% 08-09. 

Clearly, the Finance Minister has his constraints. He has to chart out a prescription, which is supposed to be more difficult than the ailment of 1990. The “era of so-called global reforms” is not over. Mukherjee is under pressure to address that from a person (Manmohan Singh) who had scripted the reforms prescription in 1991 as also from the global, particularly the western, players. Nobody wants to assert that post the Soviet era economic reforms are failing.

Mukherjee’s immediate concern is to boost housing loans. The housing industry is in a severe crisis owing to a credit squeeze enforced by the RBI to prevent speculative deals in the sector. Despite the crisis, the builders have refused to bring down the prices.

Importantly, what the Finance Minister is trying to do would not only spiral the housing prices, but would also lead to a severe default in repayments. Many lending agencies are already facing this. Owing to either a cut in their wages or a loss of jobs.  The downturn is unlikely to make any difference. Questionably, for whom is the Finance Minister fighting?

Before removing the cap on housing finance, Mukherjee must ensure that a regulatory mechanism for the sector is in place. This is difficult. The builders are against it. A section of the supporters of the Government also do not want it. The process itself requires passing an Act by Parliament which is time consuming.

The bankers have repeatedly suggested the need for the regulator. However, if the Government is serious about ensuring discipline in the housing sector it must empower the banks to institute a system to allow them to check the mode of pricing, which is often arbitrary and whimsical. So far the Government has not taken any step in this direction.

The banks owing to the lack of this power have taken the simplest step of denying loans. The Finance Minister has to understand that a mere diktat to the bankers would not be enough. It requires stern and appropriate action not only to discipline the housing sector but others as well. Besides, the FIIs (foreign institutional investors) are wreaking havoc by manipulating the rupee value. Real investment is not coming. A shaky country spends less and less. Thus, Mukherjee has to devise methods to generate demands.

In sum, an increase in public spending as suggested by State Finance Ministers is a must. Both the Central and State Governments have to break the deficit barrier. This also means straining the banking system. Given that the Governments have to borrow from them. It has its own problems. This is likely to shoot up the prices, which at the consumer level hover around 10%. But if this is invested properly, jobs would be created and growth ensured. It is likely that reconsolidation might begin in about two years.

As of now it seems that banks would not be able to help the Government much in attaining the Finance Minister’s objectives. The malaise is deeper. It requires a new prescription and a brake on the 1991 reforms process. ----- INFA

(Copyright India news & Feature Alliance)